Western business struggles to break Chinese barriers

The tantalising prospects of rich pickings from the emerging market have drawn companies to Beijing. But, as the tribulations of Google and Rio Tinto show, outsiders need to tread with care. Richard Wray and Heather Stewart report

The Chinese government's plans for homegrown business champions have led to claims of protectionism. Photograph: STR/AFP/Getty Images

There is a popular misconception that the builders of the Great Wall of China were constructing a barrier not to repulse the invading hordes but to keep their own citizens contained, to delineate the edge of empire. It is a telling outsiders' view of the country, with the wall serving as a potent symbol for the insularity of the Chinese. Recently, however, western business executives have been given reason to wonder exactly how welcome they now are behind that stonework.

China continues to expand aggressively overseas, hoovering up natural as well as economic resources. Within the country, the government's long-term plans to create a legion of homegrown business champions across crucial sectors of industry are bearing fruit. But it is sparking howls of "protectionism" from foreign rivals, and the threat of tit-for-tat trade barriers being thrown up in retaliation.

Policymakers, especially on Capitol Hill, are also sabre-rattling about the resistance of the Chinese authorities to revalue the yuan, -– undervalued by as much as 40% – with the Obama administration set to label China a "currency manipulator" in a treasury department report next month. The increasingly chilly business climate, coupled with the continuing existence of the regime's less savoury side, from repression of free speech to the use of prison labour, means some companies are having to ask themselves what they are getting out of the country or whether they might not be better off pulling out. That is not a move most would contemplate lightly, and businesses are aware that investing in China is a long-term enterprise.

"Obviously in any territory, and China is no exception, where there is rapid social change and rapid economic change then it is bound to have some stresses and strains along the way," says Nigel Rogers, chief executive of contract manufacturer Stadium Group and a man who has been doing business in China for well over a decade. "But over the longer term it remains an extremely good place to do business."

China has weathered the global economic crisis surprisingly well. Its export-led economy was hit hard, but Beijing, with the luxury of its vast foreign currency reserves, cranked up a $585bn spending package, and ordered banks to pump out credit. These measures were so successful the biggest worldwide downturn since the Great Depression made barely a dent in China's growth rate. Exports have rebounded strongly, and the Chinese authorities are now busy withdrawing the stimulus.

Some economists are concerned that China's response to the crisis has only succeeded by inflating unsustainable bubbles in other areas of the economy – the property market, for example.

Not everyone buys into that view. Mark Williams, senior China economist at Capital Economics, says: "The talk of bubbles is overdone. Property prices nationally are up a little bit more than 10% year-on-year, but that's in a country where incomes are growing faster than that."

Diana Choyleva, of consultancy Lombard Street Research, believes China's state-owned banks could be sitting on huge non-performing loans, as the Japanese financial sector was during the final years of the 1980s boom. That's fine as long as the Chinese public keep the merry-go-round moving by pouring their savings into the banks; but if inflation gets out of control, and consumers lose their appetite for saving as they watch their bank balances being eroded, she says the entire "house of cards" could collapse.

Qu Hongbin, China economist at HSBC, reckons the authorities have a good chance of wrestling inflation under control, pointing out that premier Wen Jiabao highlighted the social consequences of rapidly rising prices as his primary concern at the recent National People's Congress – and most of all, the recent rise in prices results in food inflation. He says the latest budget, which included a sharp slowdown in the pace of public spending growth, should help to bring the economy back under control, and has just upgraded his growth forecast for China this year to 10%.

But the difficulties businesses can face have been highlighted by the recent conflicting decisions made by Google and mining giant Rio Tinto. Google last week shuttered its controversially self-censored Chinese search engine, transferring all traffic to an unexpurgated site in Hong Kong in the expectation that at any moment the authorities would block Chinese web users from visiting the site. Tomorrow judgment will be handed down in the case of four Rio Tinto workers charged with bribery and stealing commercial secrets.

Many back in the Square Mile believed it was no coincidence that the arrests followed on the heels of the mining giant's decision to reject the offer of investment from Chinalco, China's state-owned aluminium group – a move that annoyed the Chinese authorities. Rio Tinto instead raised cash from shareholders and jumped into an iron ore joint venture with rival BHP Billiton. But despite having four men in the dock, Rio earlier this month signed a $2.9bn deal with Chinalco to develop an iron ore mine in the west African state of Guinea.

The case has thrown the spotlight, once again, on corruption in China. In a move that raised eyebrows among watchers of the country, state-controlled Sinopec, Asia's biggest refiner, last week laid the blame for corruption at the door of western companies, claiming that one of its employees received a bribe from German carmaker Daimler, which is currently the subject of an anti-corruption investigation in US. "We urge and hope that the government will encourage a normal market environment and good business conduct by working to severely punish audacious challenges from multinational companies and lawbreaking business people," Sinopec said in a statement.

Cynical observers might suggest the contrasting approaches of Rio Tinto and Google are symptomatic of the realpolitik practised by the extraction industry compared to the trendy dotcom set. In reality, both companies had their eyes on the bottom line when deciding how to deal with China.

For Rio Tinto, China is too large a market to ignore and is a market to which it is already heavily exposed. Some two-thirds of its iron ore finds its way to Chinese customers, helping to fuel the building explosion that has created Shanghai's crane-filled skyline. For Google, however, it may be the largest internet market in the world – with over 400 million people plugged into the web – but it represents just a tiny fraction of its $24bn a year business. Analysts reckon it makes just 1% or 2% of its revenues – $250m to $500m – from China.

Crucially, only about half of that is advertising revenue generated from within China itself: in other words, Chinese companies using Google to advertise to Chinese citizens. The rest is money spent by Chinese companies to advertise on Google sites outside China in order to attract foreign customers – and that cash will still flow. .

As for China's internal online advertising market, despite having been in the country since 2006, Google has not made much of an impression on a sector dominated by homegrown rivals such as Baidu.

Better to return when conditions are more favourable – that way, Google gains kudos for not yielding to the regime and can smooth ruffled feathers among its own staff, leaving "collaborators" such as Microsoft's Bing and Yahoo to deal with the ire of campaigners. In essence, the difference between the two approaches is that the web will outlast the regime in China, but the world's iron ore deposits may not.

But Google's withdrawal, which has so angered the administration that the State Council Information Office has even clamped down on its reporting within the country, highlights the continuing uneasy relationship between the country and western businesses. It is a relationship that has become even more tetchy in recent months because China's push for what the government terms "indigenous innovation" – put in place by Beijing's 15-year Science and Technology Plan in 2006 – is beginning to create national champions who foreign rivals believe are getting an unfair leg-up.

Myron Brilliant, the international head of the US Chamber of Commerce, the world's largest business federation, last week sounded a warning to an audience of senior Chinese dignitaries. "As we approach the 10-year anniversary of Congress awarding China permanent normal trade relations status, there is palpable and rising concern that China is becoming less friendly to foreign firms," he said, adding that policies which discriminate based on nationality of investment not only put overseas companies at a disadvantage, they also undermine China's goal of becoming an innovative economy by 2020.

"The Chamber pledges to resist protectionist approaches in the US," he said. "But, make no mistake, pressures are mounting, particularly in this election year."

His comments were all the more surprising because Brilliant has done much to rein in the worst excesses being demanded by headline-grabbing politicians in Washington DC. But looking at the figures, China is swinging against outside investment: a recent survey by the US Chamber of Commerce showed that more than a quarter of technology firms who responded reckoned they were losing out in China because of the "indigenous innovation" plan. And, in a country with a government procurement budget of 600bn yuan ($90bn) a year and state-owned companies that have a combined turnover of 22.5 trillion yuan, Beijing has some pretty powerful levers to pull for its own side.

Some British companies in the region, however, are more sanguine. "If you look at history then protectionism usually follows a period of turbulence in the world economy," points out Nigel Rogers, whose company runs a factory in the Guangdong province of China.

"In that respect, it is inevitable that some people will see protectionism as a means of achieving their aims. But in the longer term, global trade is dependent on dropping barriers and increasing the overall volume of trade. Ultimately, I think that the groundswell of enthusiasm for global trade will win the day but there may be pockets of protectionism along the way as a result of what has happened over the last 18 months in the world economy."